send not to know for whom the bell tolls

…it tolls for thee. Hat-tip to Monevator, from whom I’ve  unwholesomely pinched the phrase. There again, he swiped it from Hemingway, who got it from John Donne. We will find out on Wednesday what else is in store from the Comprehensive Spending Review, few will escape unscathed, even if only hit by dint of buying stuff, for VAT will rise to 20% from January. So far that is the only hit I know of, barring the NI hike but I believe it was the last lot who set that up.

In researching some of the previous posts I turned up some breathtaking examples of smart people who seem to take complacency to new levels – let’s hear it from

Sarah (hat tip to Lemondy for turning up that one)
Joseph and his brood of 5
Nicholas with his £500 a month nursery habit
fulltimemum
on the DT – it’s not just a Guardian thang…

Though it’s true that all these individuals have kids, this isn’t their problem. They’re all better off than most UK households, and their primary problem is  an overdeveloped sense of entitlement, a lack of foresight and suboptimal personal finances. Jacob from ERE has a wry analogy of how they got to be that way.

They live according to their means – all the way up to their income limit and in some cases beyond. It means there’s no slack in the system, and in some cases no savings either. Now it’s understandable if you live on a tough council estate and have no savings, but if you’re a higher-rate taxpayer writing for the Guardian you really can do better.

As Monevator intimates, send not to know for who the deficit reduction bell tolls. it tolls for thee. The obvious response to the distant drumbeat of cuts is above all else reduce outgoings. Sun Tzu had words of wisdom:

Invincibility lies in the defence; the possibility of victory in the attack.

Now is about defending your personal finances. The time will come later to try and improve them by increasing your income, for instance going for a better job.

Building up savings is nice, but reducing cash haemorrhages can really improve your financial position short and long-term. On the principle that it’s good to get one’s attack in first, the time to start doing this is now, so you won’t have to mount a response to  something like the loss of child benefit under fire.

That means tackling subscriptions, Sky, mobile phone packages, eating out, drinking, jazz lessons, visits to the cinema. Knowing how much you spend on these items per month is a really good start, particularly the ones which come frequently but at random like eating out.

I’m not going to bore you with the mechanics. Knowledge is power – tracking where your money is going is the key to this. I have used Quicken since 1998, and it gives a rear-view mirror perspective to my spending. Most personal finance guidance advocates setting a budget, ie trying to get a forward view on spending, but it all depends on the quality of your estimation. Mine was pretty ropey, I could only control my spending watching the rear-view. For most of those years I used Quicken to avoid going into debt and paying bank charges, living a reasonably middle-class and hedonistic lifestyle, up to, but never beyond my income. I did save indirectly, as I took the now unusual step of repaying some of the capital on my house at various times.

It was only with seeing the writing on the wall at work with some changes that drew it to my attention that I did not want to carry on doing things this way that I changed. At the time I thought I was going to be finished in a year. That concentrated the mind – I switched to intense pre-tax savings in pension AVCs and post-tax savings in ISAs – first a couple of cash ISAs to achieve an emergency fund that wouldn’t get destroyed on the stock market (it’ll just get destroyed over the next couple of years by the twin horsemen of inflation and QE), then NS&I index-linked certs for the three-year timeframe and shares ISAs for the five-year plus.

At the same time I also allocated about the same amount of resources to non-financial investments because I believe there is a significant likelihood that Britain and the West will never recover from this financial crisis, and that the financial bloodbath that started in 2007 is the harbinger of fundamental changes to geopolitical power and global resource shortages particularly in energy.

I had the advantage(?) of hearing the bell toll for me, and having a year to prepare. For pretty much anybody in the UK, but particularly anybody working in the public sector, well, chum, that bell is tolling for thee. For heaven’s sake, start preparing. Three months ago would have been a good time to start, but now is still good, and better than three months hence.

SAHM Sarah is at least on the right track, though some of her outgoings still beggar belief. F’rinstance, she’s chuffed to be saving £36pm on her car insurance. I couldn’t do that, because mine is about £20 pm fully comp, so either she is driving some fancy wheels or she is a rotten negotiator. She’s younger and a damn sight more attractive than me, but as a lady probably gets a discount for not having testosterone coursing through her veins. I hate to think how much her insurance was before!. If her husband works in Ipswich, then why on earth do they pay Cambridge house prices? For sure, Cambridge is prettier, better connected, more cosmopolitan, but is it really worth the extra costs? Plus faced with

We have no savings – all money spent on moving house six times in 10 years for my husband’s career – but we’ve stopped the £20 a month put in each of the children’s child trust funds.

Ever heard of that archaic practice called renting, dear woman? Yes, you don’t build up (negative) equity in the home, but you lose a shocking amount of money moving house if you are a homebuyer, not to mention the emotional frazzle of the process. The money lost in the home purchase turn isn’t so bad amortised over 7 years which is the average dwell time of UK homeowners, but churning your residence every two years is as nutty as churning your shareholdings every couple of months. Just don’t do it – or at least tot up the total of all those estate agents, surveyors, solicitors, mortgage arrangement and moving fees…

If you’re a banker you’re probably okay, but for anyone else in the UK live as if you’re going to take a 25% pay cut over the next year. Regardless of your risk of job loss, there are some serious economic headwinds coming our way over the next few years –

  • More expensive fuel, heating and electricity as a result of increased world demand and potential supply bottlenecks
  • a loss in the purchasing power of the pound due to quantitative easing, inflation or both
  • potential falls of house prices in real terms due to wage pressures, less money for mortgages and inflation. That is particularly bad for people with a high loan-to-value because interest rates will go up if inflation takes hold
  • Increasing food and clothing costs are a result of fuel and resource pressures

Now is not the time to be spending up to the limit of your income, like I was a few years ago. And it is definitely not the time to be spending beyond your income, no matter what the reason.

It’s time to get a personal finance tin hat – you need to electively choose to start living on less that your income even if it means doing without things, so you have space to deal with this loss of purchasing power. There’s no point in burying your head in the sand – deal with reality, otherwise reality will deal with you in its own way.

As the cited individuals show, filling in a sudden personal finance hole causes worry and grief. A sense of entitlement simply makes you blame the rest of the world for problems. It may well be the fault of the rest ofthe world, but it is easier to change yourself and your actions than it is to get the rest of the world behind your point of view.

Obviously I could be wrong, but anybody with half an ear to the news will observe that the likelihood of being richer in a few years time is less that the expectation of being poorer. Plus, what’s the worst that could happen? You scrimp and save a bit now, Britain starts booming again and you end up sitting on some saved cash? Time for that trip to Australia, pop the bubbly and have a good laugh at your ill-founded pessimism and that fruitcake at SLS.

Whereas take the ostrich mentality to the incoming crapstorm, what’s the worst that could happen? You lose your job, then your home? You start whining on the Guardian and then have lots of people say nasty things about you which brings Patrick Collinson out in hives?

Oh yes, and that bell is tolling for me too, just to show we’re all in it together. I’m not rich enough for the pension changes announced so far to affect me, but known issues I will be hit by –

  • VAT rise
  • fuel costs
  • heat/light/power
  • property/council tax rises
  • increasing costs of food
  • demise of the State pension/introduction of means testing, goodbye to 30 years NI payments for me.
  • inflation due to QE destroying a good part, ~50% if I am lucky, almost total wipeout if I’m not, of my accumulated wealth despite attempts to turn it into real stuff  and shareholdings (tin hat/optimistic portfolio)

and I’m sure George has got something thought up especially for me.

He can’t take any of my benefits away, because I don’t get any that I know of, but he can raise taxes. It is true that since I am close to the end of my working life the cumulative effect of this is less, but those readers who are at an earlier stage in your working lives and therefore more exposed can take some comfort in knowing that the devaluation of the currency will trash a significant amount of my accumulated wealth.

Plus the forthcoming house price crash will trash the nominal value of my house, though that doesn’t upset me that much as I have no mortgage. It might even give me an opportunity to upgrade. Whatever happens, the house will still keep the rain off my head.

Come on, admit it. You wrote all those newspaper articles yourself didn’t you? :-)

Hehehe, if I could look in the mirror and see SAHM Sarah I’d think about it :) ‘Fraid it’s not such a pretty sight :(

I’ve been an avid reader of your blog in the background (a lurker :-) ) for quite some time but with the current economic climate coming to what I feel to be a boiling point, I’m very interested to get your take on my current situation…

I’m currently in my late 20’s, a home owner, live and work in London in the IT trade, and wish to batten down the hatches (and have been saving aggressively) so to speak in light of potential difficult economic times ahead. Let’s say that hypothetically my current property value has held steady if not increased, in the current turbulent climate. Given the “forthcoming house price crash”, I’m toying with the idea of selling my property right now, in favour of renting over the next few years, with the end goal to perhaps benefit from being in the position to buy back in to property at a higher rung on the ladder at some future point.

I would be very interested to know your thoughts on what some may consider a risky strategy, albeit holding on to a mortgaged property at this time could arguably be considered the more risky strategy. I’m very much at a crossroads stage in life, with kids,marriage and the like potentially very near future choices, and the decisions I make now have the potential to shape many years to come…..

Personally, I think it’s worth a punt.

John, what you’re trying to do here is hedge house prices. Subject the the usual caveats of DYOR and this isn’t investment advice :) you don’t actually have to sell your house to do that.

IG Index offer options on UK house prices which you could use to hedge the prices, taking a view on where you think they will go. It is quite difficult to get your head round how much IGindex option to buy to hedge a fixed asset – I cocked this up spectacularly hedging my company sharesave shares as the option was about to come up and the shares were tanking, but it is possible to calculate – try it virtually with some shares to check your working.

Things that make doing this (either selling or hedging) hard are: the costs of moving are very high. Estate agents fees for selling, solicitors fees, mortgage arrangement fees for your new mortgage, stamp duty all add up making the cost of churn quite high, of the order of about 5-10%

The London market is anomalous and hedging with the UK market won’t reflect the fact that the London market is affected by foreign owners and the high concentration of wealth, so for instance the mortgage drought that is an issue for other UK regions may not be such an issue in London, so you have to analyse these differences and take a view.

In favour of selling up is the fact you;re at a crossroads stage in life, so you may need a different type of house perhaps in a different area, kids tend to cause that sort of change :)

One nasty if you do sell and choose to ride out a decline, is where are you going to store the released equity? Whatever financial instrument you use has to keep its value, or at least track house prices down. At the moment few cash instruments even keep up with inflation. And you have to be able to avoid being taxed on any nominal increase. Say, for the sake of argument we had 100% inflation ofer the period your were out of the market, but your financial instrument preserved its real value, so £100 became £200. Unfortunately you’d be taxed at 18% pa of any gain above 10k. You’re therefore quite a hostage to highly inflationary times. Monevator has personal experience of sitting outside the market in a low-interest high-inflation environment and he’s not a happy camper.

That’s all assuming you have a lot of the equity in the house, if you don’t then you don’t have to preserve a large sum of money in some other asset class, and can, indeed profit from a house price crash. You can still change your mind and use house price futures if you change your mind and feel them going up again, though there’s no sitting out negative equity with that option – the margin call will come and close your position!

So there are a lot of wrinkles and nasty little gotchas in there, which you need to do the what-ifs on, unfortunately.

Good luck, and really spend time on the research. Oh and congratulations – I was living in London at about your age and loved the lifestyle but couldn’t dream of getting a house, so I’m in awe of you getting on the London housing ladder!

Hope it’s okay if I add my twopennyworth here. In addition to the excellent analysis by the host, you might want to consider where you would be in the event a long slow bear market rather than a short sharp crash.

Supposing house prices fell by 5% in real terms by 2025. You might be still paying rent, waiting for that opportunity to dive in, but you would have missed the opportunity to reduce your outstanding mortgage balance to virtually negligible proportions. The reduction in value here is really irrelevant.

You need to consider, especially if kids might be on the way, whether your home is suitable as to size and location. If it’s obviously not, then that might favour the idea of renting for a while, but if you are unlikely to need to move for a bit, there’s a lot to be said for steadily whittling away at that mortgage.

Once you own a property, even while still paying a mortgage (as long as you are not likely to be in -ve equity), you should not class it directly as an asset. It’s value lies in the ability it gives you to avoid paying high rent in the long term.

@SG you make a good point about paying the mortgage down, though it is important that people do pay it down :)

@John, for what it’s worth I managed to discharge my mortgage in 20 years despite eating a 50% loss on my first house. Provided you steadily pay down the capital a price crash is not necessarily catastrophic, but years of -ve equity are seriously depressing. I was lucky in not having to move in those years, job security is lower these days, though London probably offers the best range of work opportunities so job losses don’t necessarily=move as it would up here.

However, I live in a three-bed semi where a lot of colleagues who were smarter live in 3/4 bed detached houses. Set against that, they tend to still owe money, even if they are slightly older than me. Things which made this easier for me was that I haven’t had kids, and my pay was reasonably good, though if you are a homeowner in London now I would say your pay is relatively quite a bit more than mine was at the same age.

Your situation is therefore quite complex and needs a lot of thought to find the right angle – SG raises some interesting extra issues I hadn’t spotted!

Thank you for all of your thoughts guys, I really appreciate it!

You’ve raised some really interesting points and clearly I need to give things a lot more thought.

If something seems simple, you’re doing it wrong :-)

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And I’m sure George has got something thought up especially for me.

Your only paranoid if they are not out to get you!!!!

Regards

\\Jay//

 

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